Global share markets seem to be more concentrated as earnings growth has increasingly focused on a small group of mega corporations, according to Tim Richardson, Pengana investment specialist.
Just 10 stocks now account for 30 per cent of the US S&P 500, which represents around two-thirds of the global share market.
In an op-ed penned for InvestorDaily, Richardson said that these businesses have delivered aggressive volume growth while preserving their pricing power, particularly as barriers to entry keep out competitors.
“Investors are now asking if this growth concentration will be sustained,” he said, noting that the Magnificent Seven delivered returns of 101 per cent in 2023, while the S&P 500 equally weighted index returned just 2.5 per cent.
With a select group of company giants capturing the lion’s share of value being created, Richardson said that profitability has been driven by innovation, with sectors like technology and pharmaceuticals being notable beneficiaries.
“These favour large-scale operations in which early movers scale rapidly, build strong brands and bring down average unit cost. This creates significant barriers to entry which protect the profit margins of the (usually) one or two companies that establish market dominance.”
The rise of a small group of winners is happening alongside major structural changes in the economy, which help explain the global slowdown in growth, according to the investment strategist.
The first is disruptive innovation, which highlights that the time to reach mass adoption is becoming increasingly shorter, enabling the emergence of single industry leaders.
“Supply chain risk and geopolitical rivalry is accelerating the ‘great separation’ between the two largest economies, further curtailing the level of competition in markets with high barriers to entry,” Richardson said.
He explained that demographic changes are also bringing labour shortages and higher long-term neutral rate of interest, boosting the competitive advantage of profitable incumbents.
“High government and corporate debt levels mean permanently higher borrowing costs, which brings a cost advantage to early industry leaders able to rapidly become cash flow positive,” he said.
As such, Richardson believes that the growing contribution of technological innovation and medical discovery to economic growth looks set to endure, delivering above-average margins and thus, a high share of corporate profits.
“Mega stocks showed their defensive properties during the recent period of elevated global interest rates. The effect of strong earnings growth as they captured rapidly expanding markets outweighed the textbook assumption that growth stocks are more sensitive to higher interest rates.”
However, he warned that investors should never assume that yesterday’s winners will remain this way tomorrow.
“Exciting growth opportunities also exist outside the technology sector, as the world transitions to clean energy, retail disintermediates, the ageing population spends more on healthcare and major trading blocs seek to secure their supply chains.”
To read more from Tim Richardson, click here.
